Ultra-fast traders put market at risk: Mackay

“Many of these low-latency shops are small in staff, and light on capital. Their only advantage is speed, so there is an incentive to remove risk checks,” says high-frequency trading specialist Fil Mackay.
AFR

by
Stephen Shore

The Australian sharemarket is at risk of flash crash event caused by ultra-fast traders removing risk checks to increase the speed of their algorithms, a high-frequency trading expert has warned.

High-frequency trading (HFT) specialist
Fil Mackay
works with fund managers and institutional investors to help them understand and measure the impact of HFT.

Mr Mackay said brokers that provided ultra-fast, or low-latency, traders with direct access to the Australian Stock Exchange had no way of knowing whether risk checks put in place to prevent errant trades were being adhered to by the traders.

Ultra-fast traders use algorithms to spot buy and sell orders from fund managers and trade ahead of them. A few microseconds (one millionth of second) can be the difference between a profit or a loss.

Brokers providing market access to ultra-fast traders require software to be run alongside the algorithms to ensure a trader’s order meets certain checks, for example whether it has enough capital to execute the trade.

Mr Mackay said putting the responsibility for running the software on the traders created moral hazards because the trader’s primary aim was speed.

“Many of these low-latency shops are small in staff, and light on capital," Mr Mackay said. “Their only advantage is speed, so there is an incentive to remove risk checks. The issue here is not whether the broker claims they have full control, it is whether they really do.

“Given these ultra-low latency shops are really hacker types, it is difficult to imagine how a broker could give them a piece of software, ask them to use it – and ensure the software is not able to be circumvented."

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Citigroup
,
Deutsche Bank
and
BBY
are among the biggest broker-dealers to allow other market participants to use their memberships to access the exchange.

Security systems in place

A Citi spokesman said there were security systems in place to ensure the software could not be tampered with, and if a trade was not within the parameters specified it would not go through.

“Our current software filters are integrated into the DMA system and they are not something that a sponsored access arrangement can negate, so that Citi exercises direct control over the filters and monitors accordingly," he said.

Deutsche Bank declined to comment and BBY could not be reached.

One broker said all clients were carefully vetted before market access was provided because the broker would be responsible for any market disruption caused under their name.

UBS
head of equities in Australia
Gary Head
said UBS did not provide market access to low-latency traders for compliance reasons.

“UBS is required to have its own ­filters in place and we cannot rely on other firms to perform those checks," Mr Head said.

A spokesman for the Australian Securities and Investments Commission said the regulator had done a lot of work considering the appropriateness of trading systems and controls to ensure fair and orderly markets.

“All systems that allow automated order processing must have appropriate pre-trade filters and controls to ensure markets remain fair orderly and transparent," he said.

ASIC’s new market integrity rules to address risks emerging from developments in market structure, including growth in automated trading, come into full effect by May 2014.

They include the requirement that market participants have direct and immediate control over filters and orders and have automated controls to suspend orders and/or systems that have caused or may disrupt the market.